Effects of Falling House Prices on the UK Economy Term Paper

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Introduction

The question of whether falling house prices affect the economy lingers in many people’s minds. Some think the houses in the UK are overvalued and would therefore naturally fall after a given time. Other people however suggest that the falling of house prices would eventually result in an economic recession. The following are the effects of house price falls on the UK economy (Artis 1996):

Low consumer spendingHousing is the greatest form of wealth in the UK. The general belief in people is that house prices will always increase. The effect may be significant when this is not the case as it may lead to a deterioration of consumer confidence hence low consumer spending. People will not be willing to enter into risky investments and borrowing will as a result be very low leading to a slow economy (King 1980).

Recession

King (1980) points out that, there are people who enter into huge mortgage deals expecting that when the house prices rise they will remortgage and benefit from the surplus. When the prices fall they will be faced with negative equity, a situation whereby the value of a house is greater than the mortgage debt. This may incite people to again buy the houses at present low prices but if the downfall is not yet over they will make losses and counter losses leading to a temporary economic recession, a situation whereby economies experience negative economic growth. Such was the case in 1991 when the house prices dropped by 15% contributing to the recession of 1991-1992.

Economic growth

Though complex, the low house prices may lead to low consumer spending which is likely to reduce the pressure of inflation in the economy. This in turn will trigger the bank of England to lower interest rates hence the consumer spending will increase leading to a better economy (Artis 1996).

Strengthening of local economies

This is a positive impact on the economy. In the past, the ratio of increase in house prices has been higher than the increase in incomes. Many first-time buyers, as a result of this, have difficulties in buying homes. The inability to afford the house has led to a shortage of key public workers, for example; policemen and teachers which greatly affects the local economies. However, when the housing prices fall, more workers will be able to afford them hence strengthening the local economies.

Measures the government can take to mitigate falling house prices:

The current housing market decline in the UK economy has reached a situation where the government needs to take appropriate measures to help revive the situation. The government should reduce or create an end to strict market intervention that hinders raising prices which may improve the market. The government has set housing targets of the expected number of houses to be completed by the year 2016 but with the downturn, it is unlikely that this will be achieved because house builders will not afford to have excess supply, which they are not able to sell (World Economic Outlook 2007).

According to Artis (1996), the government should aim at creating a viable house-building industry. The demand for houses has continued going up but with the low supply, the market structure is greatly affected. The government needs to set a long-term capacity in the housing sector that will favor both the suppliers and the purchasers so that an appropriate market situation may be enhanced. This may be through:

Providing direct benefits to an individual or private housebuilders through funds or other technical assistance.

Expanding the publicly controlled home-buy schemes to provide resources for those intending to purchase new housing property.

The government needs also to create a priority to reducing the excess supply that is already prevailing. The government in this aspect should assist builders to sell the over-supply at affordable but favorable prices and then come up with plans that will ensure supply goes hand in hand with demand. Through its targets, the government is able to know the number of houses that need to be constructed annually and it should encourage builders to use the targets to guide them on the extent of supply that should be in the market (Economic Outlook, 2003).

Improving the mortgage credit is another way in which the government may help improve the falling prices. Many house builders are not able to re-mortgage because the value of their houses has one down or because they still have credits and do not, therefore, qualify for a new mortgage. By improving the terms of mortgaging, the government will be enabling the house owners to create value in houses and hence overcome the low prices (OECD Economic Survey: UK 2005).

References

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